Offshore outsourcing represented just 3 percent of the $725 billion spent on global IT services in 2004, but it is becoming more important to IT outsourcing providers, according to findings of a new joint study by Bernstein Research and Everest Research Institute. "Is Offshoring Sustainable?" found that offshoring, more than any other factor, is driving growth and profitability among the large IT outsourcing-services providers.
In analysis of the world's major IT services providers, the study grouped the major outsourcing suppliers into three categories based on levels of offshore adoption: India players, such as Wipro, Infosys, and Cognizant (whose employees are for the most part located offshore); aggressive offshore adopters, such as Sapient, Perot, and ACS (early adopters of offshore labor); and traditional players, such as IBM Global Services, EDS, BearingPoint, Accenture, and CSC (which have a small, though growing, percent of their work staffed offshore).
The report found that IT service providers who are primarily based in India achieve higher margins. In 2004 net margins of the top-six Indian suppliers averaged 22 percent, compared to only 4 percent for six major traditional suppliers. India-based service providers also benefit from higher free cash flows. The top-six India players combined generated nearly $1 billion in free cash flow in the past year. "This translates into higher profit margins for those Indian companies," says Joe Fernandes, managing director for Everest Research Institute. "The actually profit margins are fundamentally higher, 21 percent for the Indian pure players, versus 4 percent for the traditional companies."
The report also found a direct correlation between those IT services that are offshored and company growth. The top India suppliers are growing revenues at an annual rate of nearly 40 percent, while the major traditional suppliers at only 3 percent. "Those IT service providers that offshore their services are growing quicker than traditional players," Fernandes says.
Report findings also indicate a 30 percent growth in offshore outsourcing demand over the next three years. "Those who downplay the size of the offshore market and dub it a commodity business are really missing the boat," says Rod Bourgeois, senior research analyst, computer services and IT consulting, Bernstein Research. "Offshoring is having an enormous impact on industry economics. This will only continue as offshore demand over the next several years is supported by a strengthening value proposition and multiple industry trends."

Those trends include the rebuilding of large-scale outsourcing contracts and a shrinking supply of IT talent onshore. These, in turn, will prompt buyers to look offshore for talent and new contract structures, according to the findings. Additionally, the ability of companies to offshore more services, such as BPO and IT infrastructure, is making offshoring more popular than ever. "As more and more companies rebundle their work, they're beginning to move many services to best-of-breed companies," Fernandes says. "Previously, companies with big outsourcing contracts and lots of suppliers are now taking pieces of those outsourcing contracts and giving it to specialist firms. Many of these specialist firms are offshore."
Despite the generally negative perception of offshoring, Fernandes contends that the improvement of various offshore markets is good in the long run. "As offshoring markets mature, in terms of skill sets it allows companies to rebundle how they do offshoring," he says. "This is a positive story--less about taking jobs away versus being able to create more business options because of lower cost structures."
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